Ratemaking Principles: A Comprehensive Analysis of Texas Insurance Practices

1. The Contest - Part I CAS Seminar on Ratemaking SPE - 47 Thomas L. Ghezzi, FCAS, MAAA Katharine Barnes, FCAS, MAAA

2. Judging Based on Application of Actuarial Ratemaking Principles andStandards of Practice and Quality of Documentation in Actuarial Report • Gave Lots of Weight to the CAS Statement of Principles Regarding Property and Casualty Insurance Ratemaking • Data Credibility and Homogeneity • Loss Development, Trend, Etc. • ACTUARIAL JUDGEMENT • We Set out to Get the Best Possible Answer • Quirks of Texas Law to be Debated at the Hearing • We Used All Relevant Data and Noted Uncertainties Where Appropriate

3. Actuarial Report Designed to Document Data, Judgments and Assumptions • Relied on SOP 9 - Documentation and Disclosure in Property and Casualty Insurance Ratemaking, Loss Reserving and Valuations • Documentation Sufficient for Another Actuary Practicing in the Same Field to Evaluate the Work • We Added an Additional Goal that the Analysis be as Understandable as Possible to Non-Actuaries • Value-Added

4. This Ratemaking Problem Not Unlike Most Ratemaking Applications Encountered in Real Life - Only the Details are Different • Statutory Rate Standards Similar to Most States • Rates to be “just, reasonable, adequate, not excessive, not confiscatory and not unfairly discriminatory” • Complications • Data Issues • Plan Population Changes • Tort Reform • Lots of Judgment Required

5. Biggest Areas of Judgment and Uncertainty in Almost All Analyses - And the Source of Most Arguments at Rate Hearings - Are Present Here • Loss Development • Trend • Frequency • Severity • Pure Premium • Expenses Other Issues Are Important Too, But We Will Concentrate on These Three Areas

6. There Are Essentially Three Sources of Loss Development Data - Each With Advantages and Disadvantages • Stat Plan Data - Involuntary Market Advantages Disadvantages Invol Market Low Volume (Credibility) Basic Limits Data Change in FR Limits • Stat Plan Data - Total Market Advantages Disadvantages Good Credibility Dominance of Voluntary Data Total Limits • ISO/NAII Texas Data Advantages Disadvantages Good Credibility Dominance of Voluntary Data Current FR Limits Sample of Carriers No Maturities > 63 (or 39) Mos

7. Given the Advantages and Disadvantages, We Believe that All Three Sources of Data Should be Considered - Example for Bodily Injury

8. There are Two Basic Sources of Texas-Specific Trend Data • Trend Data Survey • Calendar Quarter Data - 1991 -1996 • Total Limits • Paid Losses and Paid Claims • Involuntary Separate from Voluntary • ISO Fast Track Data • Calendar Quarters 1993 - 1997 • Total Limits • Paid Losses, Paid Claim Counts and Arising Claim Counts (BI and PIP Only) • Total Market

9. There Are Several Complications That Make the Trend Analysis More Uncertain Than Usual • Use of Calendar Quarter Data • Causes Mis-match Between Exposures and Paid Losses and Claims • Mis-match Exacerbated by Changes in Involuntary Exposure Level • Tort Reform in 1995 • Trend Data Spans Pre- and Post-Tort Reform Periods

10. In Order to Make Use of the Maximum Amount of the Available Data, We Made Several Adjustments • Lagged Exposures • Exposures Adjusted Based on Estimated Paid Loss Development Patterns • Theoretically Corrects for Mis-match • Tort Reform Adjustment • Pre-Tort Reform Accident Periods Adjusted by 7.5% Tort Reform Effect Approved by the Commissioner • Use Loss Development Patterns to Estimate the Portion of Calendar Period Data Related to Pre-Tort Reform Accident Periods

11. The Changing Volume of Plan Business Makes the First Adjustment Significant for the Survey Trend Data - Example for Bodily Injury Exposures

12. The Tort Reform Adjustment, While Important, is Less Significant - Example for Bodily Injury Losses

13. Combined, These Adjustments Have a Significant Impact on the Survey Trend Data Pure Premiums. Apparent Upward Trend Turns Downward (Similar to Total Market Trends) - Example for Bodily Injury

14. Additional Trend Complications Are Handled Judgmentally • Changing Plan Population • Underlying Cost Changes Could Be Related to Factors Other Than Trend • We Gave Some Weight to Total Market (i.e., Fast Track) Trends • Total Limits Data • Would Expect Basic Limits Trends to be Lower • Data Does Not Always Behave This Way • Use of Pure Premium Trends • Avoids the Need to Make Separate Claim and Loss Adjustments

15. Expense Loadings Are Mostly Straightforward, With a Few Relatively Minor Complications • Four Main Categories • Commission and Brokerage • Other Acquisition • General Expenses • Taxes, Licenses and Fees • Texas and Countrywide Data Available • Some Unusual Considerations and Adjustments Needed

16. Some Expenses Are Explicitly Disallowed for This Analysis • Advertising, Lobbying, Contributions, Bad Faith Awards, Penalties or Fines, and Fees to Advisory Organizations • Relatively Minor

17. Variation in Indications by Type of Carrier Poses Unusual Complication in Estimating Acquisition Expenses • Commission and Brokerage • Set Contractually at 10% • Other Acquisition • Other Acquisition Expense Ratio Indication Higher for Non-Stock Companies Than For Stock Companies • May be Definitional and/or Accounting Differences • Use Total Market Combined Commission, Brokerage and Other Acquisition Data, Minus 10% Commission and Brokerage Loading

18. Data Exists That Implies Greater Effort Required to Service Involuntary Market Business than Voluntary Market Business • Adjust Other Acquisition and General Expenses • Start With Countrywide Ratio Indications • Adjust to Reflect Data that Residual Market Expenses are 49% Higher than Voluntary Market Ratios Imply

19. We Believe that Trend and Rate Level Adjustments are Needed for Other Acquisition and General Expenses • Base Expense Trends on CPI and Average Weekly Wages of Employees of Fire and Casualty Insurers • Judgmentally Assume 50/50 Weighting of These Two Indices • Further Adjust Historical Ratios to Current Rate Level